How to Beat the Market — Buy What Your Friend’s Friend is Buying

Yale economics professor Robert J. Shiller wrote a stellar column in The New
York Times at the beginning of September. It sought to explain whipsaw trading
in August via "a Keynesian beauty contest" on Wall Street. So what's the
reason for the market volatility, Mr. Shiller? John Maynard Keynes supplied the
answer in 1936, in "The General Theory of Employment Interest and Money," by
comparing the stock market to a beauty contest. He described a newspaper contest
in which 100 photographs of faces were displayed. Readers were asked to choose
the six prettiest. The winner would be the reader whose list of six came closest
to the most popular of the combined lists of all readers. The best strategy,
Keynes noted, isn't to pick the faces that are your personal favorites. It is
to select those that you think others will think prettiest. Better yet, he said,
move to the "third degree" and pick the faces you think that others think
that still others think are prettiest. Similarly in speculative markets, he
said, you win not by picking the soundest investment, but by picking the
investment that others, who are playing the same game, will soon bid up higher.
It's a fascinating theory and one that has even more evidence after the
antics of August continued this month. As I wrote a few days ago , it's not
"news" moving this market because frankly, there's nothing new here.
Europe is up to its eyeballs in debt, unemployment is high, yadda yadda yadda.
There clearly is more at work here than fundamentals or chart watching. So maybe
it's other investors that Wall Street is watching these days more than
anything else. The idea of second-degree investing based on what you think
others are buying and selling or even third-degree investing based on picking
stocks you think other investors are buying based on what still others are
buying is a bit of a head-scratcher. But it certainly is one way to explain
wholesale selloffs and $100 daily declines in the price of gold . How to Get
Rich With Third-Hand Stock Picks I'll admit this is highly counterintuitive.
Stock picks that are exclusive tend to be the best, right? That's why insider
traders get busted. If buying things late made you rich, then we'd still be in
a dot-com bubble. But you can't look at it that way. You have to think about
the fact that what makes sense to you might not make sense to other investors.
Even if you're "right" and a stock's earnings and revenue are ugly, if
two people want to buy that stock and only you are selling it, the price will go
up.